Financial Crisis 101 - 10/23/08

If the financial crisis was first sparked by the collapse of the housing market, and by too many homeowners defaulting on their mortgages, then does it make sense for the government to help homeowners who are drowning in what are called under water mortgages? As we explained yesterday, those are mortgages that are bigger than a home is worth. This is a touchy political issue, because some lawmakers have trouble with the idea of providing help to lenders who made bad loans and consumers who took them. But others say that the economy is getting hammered by the continuing housing crisis, and won't recover until housing is stabilized.

People like FDIC chairwoman Sheila Bair presented some federal help options to the Senate Banking Committee today, and while they are almost complex enough to require a PhD in economics to understand them, Committee Chairman, Senator Christopher Dodd reacted to one of the proposals this way: "This slender provision alone can help countless deserving Americans escape the foreclosure trap set by predatory lenders."

The extent of the mortgage crisis is scary. According to Moody'sEconomy.com, as reported by the Wall Street Journal, 7.3 million Americans are expected to default on their mortgages between 2008 and 2010. That's about triple the number during normal economic conditions. Would renegotiating many of these mortgages so homeowners can stay in their homes and get themselves above water solve the financial crisis? Most experts would say not by itself. But until the housing market returns to some semblance of normalcy, they say, the economy cannot move away from the threat of collapse, even if it means helping the greedy and the foolish.

Former Federal Reserve Chairman Alan Greenspan put it this way this morning: When home prices finally stabilize, "the market freeze should begin to measurably thaw, and frightened investors will take tentative steps toward re-engagement with risk."

Greenspan testified before the House Oversight Committee, and it was really interesting because some experts and lawmakers (I don't mean that the two are necessarily mutually exclusive) have been claiming that Greenspan is partly to blame for the crisis in the first place. They say he kept interest rates too low in his desire to encourage the housing boom that inevitably became the housing bubble. They say he refused to use the powers of the Fed to sufficiently regulate new kinds of mortgages, like the subprime loans that eventually collapsed.

Greenspan acknowledged today that the financial crisis has left him in a state of shocked disbelief over the failure of lending institutions to protect their shareholders. Greenspan said that the current crisis had "turned out to be much broader than anything I could have imagined." But Committee Chairman, Henry Waxman, was in no mood to let Greenspan off the hook. He insisted that the Fed, the Treasury Department and the Securities and Exchange Commission all contributed to the problem. "The list of mistakes is long, and the cost to the taxpayer is staggering. Our regulators became enablers instead of enforcers. Their trust in the wisdom of the markets was infinite. The mantra became that government regulation was wrong. The market is infallible.

Without defending himself, Greenspan said, "Given the financial damage to date, I cannot see how we can avoid a significant rise in layoffs and unemployment. But Greenspan did say a few words of encouragement. While he called the current crisis a credit tsunami, he advised that the country will emerge from it with a far sounder economy.

Let's talk for a minute about Russia. Certainly, the Kremlin has been flexing some muscle recently, and if the military action in Georgia represents a new approach to foreign policy, then it's not outside the realm of possibility that we're at the dawn of a "Cool War". Prime Minister, Vladimir Putin was quick to say that the financial crisis in the U-S is a sign that the era of American global economic leadership is drawing to a close. Maybe, maybe not. But it's difficult to understand why Putin and the boys should appear like they're gloating over troubles here when their economy is in BIG trouble.

The plunge in oil prices by more than half has been devastating to Russia. The spigot to all those petro dollars that were to finance a return to world prominence has suddenly been turned off. Reports say that tensions behind the Kremlin walls have been going up as precipitously as oil prices have been going down. With oil revenues declining, the government had to pledge 200 billion dollars to prop up the banks.

You think the U-S stock market has trouble? Russia's is down 70 per cent from its peak last May. And over the last number of weeks, antsy investors have been pulling money out of Russia, looking for safer havens; their preference, U-S Treasury bills. Since the night the lights went out in Georgia, the second week in August, 52 billion dollars in private capital has left Russia, that according to Goldman Sachs. Maybe Vladimir Putin spoke too soon.